When you’re buying a business, you need to know how much money it really makes. On the surface, that might sound straightforward: look at revenue, subtract expenses, and see what’s left. But in reality, it can be more complicated. Owners might pay themselves in unusual ways, run personal expenses through the business, or have big one-time costs that don’t reflect ongoing operations. That’s why financial metrics like SDA (often discussed together with SDE, or Seller’s Discretionary Earnings) and EBITDA are crucial.
These two metrics help you understand a company’s underlying profitability, but they capture slightly different aspects of how the money flows in and out. By knowing both, you can avoid nasty surprises and negotiate a fair deal. In this article, I’ll break down how SDA and EBITDA work, show you how they’re calculated, and explain which one might be more appropriate for your situation.
Why Financial Metrics Matter in Business Acquisitions
When you buy a business, it’s easy to get distracted by top-line numbers like total annual sales. But total revenue doesn’t always show how profitable the business really is. A company might have a big revenue figure but also have huge overhead costs, unneeded expenses, or unusual owner benefits hidden in the books.
- Due Diligence Clarity: Metrics like SDA and EBITDA help potential buyers gauge the true operational health of a company.
- Valuation Guidance: These metrics are often multiplied by an industry-specific factor (the so-called “multiple”) to estimate a fair purchase price.
- Negotiation Leverage: If you can identify inflated or discretionary expenses, you might negotiate a lower purchase price or push for certain adjustments.
- Comparison Across Different Companies: EBITDA, for instance, allows buyers to compare businesses on a more level playing field, removing some accounting quirks.
You can’t just rely on surface-level numbers. Understanding SDA and EBITDA can save you from overpaying and highlight the business’s core earning potential.
Understanding SDA (Seller’s Discretionary Adjustments)
“SDA” is sometimes used interchangeably with “SDE,” which stands for Seller’s Discretionary Earnings. The idea behind SDA is to capture all the adjustments necessary to reflect what the current owner freely chooses to spend on themselves or take out of the company. In other words, it identifies the discretionary financial items that might disappear or change once a new owner steps in.
How SDA Relates to SDE (Seller’s Discretionary Earnings)
- SDE is basically the total financial benefit one full-time owner-operator can extract from the business in a year.
- SDA is the set of add-backs and normalizations that produce that SDE figure.
An owner might pay themselves a salary that’s much higher (or lower) than what a new owner or a professional manager would earn. They might also run personal expenses (like family vacations, car payments, or gym memberships) through the company’s books. SDA captures those discretionary items. When you add them (or remove them) properly, the result is SDE.
Calculating SDA (or SDE)
Although different people use slightly different terms, the process generally looks like this:
1. Start with Net Profit (Net Income)
Begin with the business’s reported net profit, which is the amount remaining after all operating expenses, taxes, and other costs have been deducted. This figure serves as the baseline for the calculation. However, net profit alone doesn’t always reflect the true earning potential of a business. It’s essential to adjust for any owner-specific decisions, accounting practices, or one-off events that may skew the reported figure. For instance, if the business has been overly conservative in recognizing revenue or aggressive in writing off expenses, these factors need to be considered.
2. Add Back:
- Owner’s total compensation and perks (salary, distributions, benefits)
- Non-cash expenses like depreciation and amortization
- Interest (since a new owner may have a different financing approach)
- Taxes (if they don’t reflect ongoing operations, such as personal taxes in some cases)
- Discretionary or personal expenses (family travel, personal vehicle costs, etc.)
- One-time or extraordinary costs (unusual legal fees, a failed one-time marketing campaign, etc.)
3. Subtract:
- A fair market salary if the current owner’s salary is abnormally high or low, because a future owner (or manager) would need that compensation replaced at standard market rates.
- Any irregular income or windfalls that won’t continue.
When you finish all these additions and subtractions, you end up with Seller’s Discretionary Earnings – the figure that reflects the money someone taking over could expect if they ran the business full-time, paid themselves the going rate, and didn’t have extra personal expenses hiding on the books.
When to Use SDA/SDE
- Smaller or Owner-Operated Businesses: SDE or SDA-based calculations are most common when the owner is heavily involved in day-to-day operations.
- Businesses with Blended Personal & Business Expenses: If the line between the owner’s personal finances and business finances is blurred, SDE helps clarify.
- Individual Buyers: A buyer who plans to run the business themselves often wants to see SDE to know their take-home potential.
Understanding EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It’s another approach to measuring a business’s core operating profitability, but it strips out certain non-operational or non-cash expenses, as well as financing and tax structures that might not apply to a future owner.
While SDE is more common for small or owner-operated businesses, EBITDA is standard for larger companies, especially when dealing with private equity groups, strategic acquirers, or public markets.
How EBITDA Is Calculated
1. Begin with Net Income (the traditional bottom line after costs and taxes).
Start with the company’s net income, which is the final profit reported after all costs, taxes, and expenses have been deducted. This is the traditional “bottom line” figure and serves as the foundation for calculating EBITDA. However, keep in mind that net income can be influenced by one-time events, financing choices, or tax strategies that may not reflect the business’s core operational performance.
2. Add Back:
- Interest: Because it reflects the specific financing choices of the current owner (e.g., business loans).
- Taxes: For instance, corporate income tax. Not all future owners will face the same tax burden or structure.
- Depreciation: Non-cash expense that spreads the cost of a tangible asset (like machinery) over its useful life.
- Amortization: Non-cash expense, usually for intangible assets (like trademarks or patents).
EBITDA is often viewed as a way to see the business’s profitability if you remove certain elements that can vary wildly depending on ownership or accounting methods.
Variations: Adjusted EBITDA vs. Standard EBITDA
Most buyers and sellers use Adjusted EBITDA rather than standard EBITDA. Adjusted EBITDA includes the same basic components but also adds (or removes) extraordinary expenses or one-time charges that aren’t expected to be part of everyday operations going forward. This adjustment helps buyers focus on sustainable earnings. For example:
- One-time litigation costs (lawsuits that aren’t ongoing)
- Costs related to a major, non-repeated marketing experiment
- Owner’s above-market salary (similar logic to SDE, but only the portion above or below a market wage)
When to Use EBITDA
- Mid-Size to Larger Businesses: Companies that generate over $1 million in net earnings often end up using EBITDA multiples.
- Multiple Owners or Management Teams: If the business already employs professional managers, EBITDA is a cleaner figure.
- Institutional Buyers: Private equity groups and strategic acquirers frequently rely on EBITDA or Adjusted EBITDA to compare businesses.
- Comparisons Across Industries: Because EBITDA is a common financial metric, it’s easier to benchmark across peer companies in the same market segment.
SDA vs. EBITDA: Core Differences
When exploring the financial strength of a business, SDE (or SDA) and EBITDA provide two different but complementary viewpoints. While both shed light on how profitable a company is, they handle owner compensation, expense calculations, and potential valuations in distinct ways.
Owner Involvement and Salary Treatment
SDE (or SDA) starts from the assumption that the owner is a hands-on operator. This means it factors in the full amount the owner takes from the company, covering wages, distributions, and personal benefits, and then adjusts that figure by subtracting a fair market salary if the current compensation is way above or below normal. By contrast, EBITDA typically focuses on the business as if it can operate with a standard management structure, so it only adds back the portion of the owner’s compensation that deviates significantly from a market-level salary.
When a business is deeply tied to the owner’s day-to-day efforts, SDE (or SDA) often provides a clearer picture of potential earnings for a new, hands-on owner. Meanwhile, EBITDA is more about evaluating how the company stands on its own, assuming a hired or existing management team can keep things running.
Applicability to Small vs. Larger Businesses
SDE is heavily used for smaller, owner-operated entities – think local HVAC services, a single-owner machine shop, or a boutique store where the proprietor wears many hats. These businesses typically have one primary individual directing day-to-day tasks, so understanding the total cash flow available to that individual is key.
EBITDA, on the other hand, is the standard yardstick for bigger companies, especially those on the radar of private equity firms or strategic acquirers. Larger corporations often have professional managers in place, which makes the owner’s specific salary arrangements less central to assessing overall profitability.
Expense Inclusions and Exclusions
In SDE (or SDA) calculations, all operating costs are initially included, but personal or discretionary expenses linked to the owner are then added back. That might involve personal vehicle costs, owner’s health club fees, or even family trips recorded as “business” travel.
EBITDA removes interest, taxes, depreciation, and amortization from net income and often removes certain non-recurring or extraordinary items. Yet it doesn’t automatically add back the full owner’s salary unless it’s substantially higher or lower than what the market would pay someone to do a comparable job. The idea is to standardize profitability across various companies by leaving out financing and non-cash elements that can differ widely from one entity to another.
Impact on Valuation Multiples
Because SDE (or SDA) recaptures the entire owner benefit, the resulting number is usually larger than EBITDA for the same business. However, the multiple applied to SDE is typically lower, often between 1x and 4x, reflecting the risk profile and size of most owner-operated companies.
EBITDA, especially for medium to large firms, tends to be a smaller figure (since it excludes only part of an owner’s salary) but often commands higher multiples. These can range from about 3x up to 7x (and occasionally beyond) when companies have earnings well into the millions or operate in lucrative markets.
| Aspect | SDE (SDA) | EBITDA |
| Owner Involvement | Assumes owner is fully engaged; adds back total owner compensation | Assumes business can run with non-owner management; adjusts only for salary above/below market rates |
| Typical Business Size | Ideal for smaller, owner-operated firms | Standard for mid-size to large companies or those seeking private equity/strategic buyers |
| Expense Treatment | Includes personal and discretionary owner expenses as add-backs | Excludes interest, taxes, depreciation, and amortization; may also exclude large one-off costs |
| Valuation Multiples | Generally lower (1x-4x range), though the dollar figure can look larger | Often higher multiples (3x–7x or more) because the profit figure is typically smaller, but is viewed as standardized |
| When to Use | When the buyer or seller wants a clear view of cash flow for a hands-on owner | When looking at standardized performance, especially if the company will be run by a hired management team |
Factors that Influence Multiples and Final Valuation
Deciding on a final purchase price isn’t just about plugging numbers into a formula. While you do start with SDE or EBITDA and choose a multiple, there are broader market conditions and company-specific traits that dictate how high or low that multiple goes. Below are a few core elements that often have the biggest impact on valuations:
1. Industry Dynamics
Not all sectors are created equal. Businesses operating in stable or high-demand arenas, such as essential manufacturing processes or recurring-service models, frequently receive stronger multiples because buyers see inherent resilience and ongoing demand. By contrast, companies in trendier or highly volatile niches may face more skepticism from buyers, pushing multiples downward.
2. Growth Potential
Few things entice a buyer more than clear, tangible growth prospects. If the business can realistically scale, whether through expanding its product lines, entering new markets, or leveraging unmet customer needs, investors are often willing to pay a premium. On the flip side, if the firm’s performance has stalled or is slipping, that uncertainty usually erodes confidence and brings the multiple down.
3. Earnings Stability and Recurring Revenue
Recurring revenue, like ongoing subscriptions or long-term service contracts, provides a reliable financial foundation that’s attractive to acquirers. Strong monthly or yearly commitments also show that customers find lasting value in the product or service. In contrast, companies relying on a handful of big customers or unpredictable revenue streams may look riskier, leading buyers to offer a lower multiple.
4. Geographic Factors and Competitive Landscape
Beyond just the numbers, location and competition can heavily influence perceived value. A business with a strong regional presence, favorable demographics, or limited direct competitors tends to be viewed as more defensible, which can bump the multiple upward. But if it’s operating in a fiercely competitive market where rivals offer similar services or products, the resulting uncertainty often drives valuations lower.
In practical terms, buyers weigh all of these factors, along with the underlying financial metrics, when deciding how much they’re willing to pay. A company that excels across industry stability, growth opportunity, earnings consistency, and geographic positioning will typically command a premium multiple, while weaknesses in any one area can reduce the final figure.
Practical Tips When Reviewing SDA and EBITDA for a Potential Deal
Evaluating SDA or EBITDA isn’t just about plugging numbers into a spreadsheet. It requires a deeper look into how those figures were derived and whether they accurately capture the business’s true operational health. The pointers below can help you spot red flags, highlight growth opportunities, and make a well-informed decision, whether you’re buying or selling.
Clarify the Documentation
- Obtain Complete Records: Ask for several years’ worth of profit and loss statements, balance sheets, and tax returns to identify patterns over time. One-off or partial reports can hide important details.
- Pinpoint Potential Personal Costs: Study line items like “office supplies,” “consulting,” or “travel” to see if they contain owner-specific or family-related expenses that have been run through the business.
Validate ‘Add-Backs’ Thoroughly
- Check Genuine One-Timers: Ensure so-called “one-time” costs don’t reappear each year under a different label. A recurring lawsuit expense, for example, isn’t truly a single-event charge.
- Confirm Discretionary Items: If the business claims certain expenses were purely personal, make sure they weren’t essential to day-to-day operations, legitimate spending can’t simply be reversed to boost the earnings figure.
Look Past the Financial Snapshot
- Customer Concentration: Ask for a breakdown of revenue sources. If one or two clients account for half the sales, that dependency represents a significant risk not always visible in standard SDE or EBITDA numbers.
- Industry Shifts: Even a stable EBITDA won’t protect against market changes like new technology or emerging competitors. Keep an eye on trends that could undermine long-term profitability.
Assess Historical Trends
- Compare Multiple Periods: Examine at least two or three years of financial data to understand performance trajectories, whether it’s steady growth, a plateau, or a decline.
- Investigate Large Swings: Sudden spikes or drops in revenue or expenses may signal a major contract win, a new product launch, or a one-off event. Pinpoint what caused those changes to gauge their effect on future earnings.
Conclusion
Navigating a business purchase can feel daunting, but having a solid grasp of metrics like SDA (SDE) and EBITDA helps you cut through the confusion. Each metric offers a unique window into a company’s underlying profitability, revealing how owner compensation, personal expenses, or non-operational costs may shape the final bottom line. When you understand these nuances, you’ll feel more confident identifying a fair price and zeroing in on a business that fits your goals.
Whichever metric you rely on, remember it’s just one piece of the puzzle. Factors like industry trends, recurring revenue, and customer concentration also play major roles. By pairing the right financial analysis with a clear-eyed look at the business’s broader context, you’ll be better prepared to negotiate and steer your new venture toward success.
FAQs
If you’re going to be a hands-on owner, SDE (or SDA) might give you a more accurate picture because it accounts for all the ways an owner can take income from the business. EBITDA is more common for bigger companies that run under professional managers.
Dig into past financial records. If you see that same type of expense showing up each year, it’s not really a one-time event. True one-off expenses typically have a clear, non-repeating cause, such as a unique legal case or a short-lived marketing experiment.
It depends on the lender’s focus and the size of the deal. Many lenders and institutional investors are comfortable with EBITDA, especially for larger transactions, while smaller, local lenders might look more closely at SDE if the business is owner-operated.
In that case, you’d still want to factor in a fair market wage for replacing their role. If the owner is underpaying themselves, you’d adjust upward to reflect what someone else would need to do the same job.
EBITDA is generally lower as a raw number because it doesn’t include the entire owner’s compensation. But because the metric is viewed as a standardized gauge of operating performance, especially for mid-size and larger firms, buyers and investors may be willing to pay a higher multiple on those earnings.
Most buyers look at least three years back. This helps you spot patterns, identify “one-time” events, and see if the business is growing, stable, or declining. If the company has been around longer, you can always request more data for additional insights.